Recently, in IBEW Local 90 Pension Fund v. Deutsche Bank AG, No. 11-cv-4209, 2013 U.S. Dist. LEXIS 155136 (S.D.N.Y. Oct. 29, 2013), District Judge Katherine Forrest declined to certify a class of securities plaintiffs and granted the defendant, Deutsche Bank’s (DB), Daubert motion to exclude all testimony of the plaintiffs’ market efficiency and damages expert. This relatively rare ruling is significant for securities defendants and their D&O insurers. As the court observed, because the vast majority of securities cases settle once a class is certified, class certification has come to mark a “crucial inflection point in securities litigation.” The case highlights a significant hurdle that securities plaintiffs may face at the class certification stage. Moreover, the decision illustrates how foreign issuers in a post-Morrison environment may be further insulated from U.S. liability even as to that portion of their securities traded on a domestic exchange.

Overview

In June 2011, IBEW Local 90 Pension Fund (IBEW), on behalf of itself and similarly situated investors, filed a securities action against DB based on alleged misstatements and omissions in connection with certain residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs). IBEW alleged that during the class period “DB engaged in a fraudulent scheme to profit by originating and acquiring defective mortgages for securitization and re-securitization into its RMBS and CDOs and misrepresenting to investors its risk management practices.” In support of its class certification motion, IBEW submitted declarations from its expert, Mark A. Marek, concerning market efficiency and damages issues. Marek opined that DB securities traded in an efficient market, such that misinformation concerning RMBS and CDOs would be reflected in the price of those securities at any given time. If true, individual reliance by an investor on an alleged misrepresentation would be presumed.1 DB challenged Marek, arguing that his proof of market efficiency “fell short of the mark.”

Testimony Concerning Market Efficiency Failed to Consider the Primary Market in Which the Security Was Traded

The court held, in part, that Marek’s conclusions regarding market efficiency for DB securities were the result of flawed methodology. Marek focused his analysis solely on DB securities that were traded on U.S. exchanges. He opined that these securities traded in an efficient market during the class period, but he failed to account for the “plainly important considerations” that more than 90 percent of DB’s securities were traded outside of the U.S. on the German market, and the impact of the financial crisis on the price of the securities (including short sale bans in both the United States and Germany during the class period). Marek also misread his own data sets, erroneously believing certain information reflected DB securities traded on the NYSE alone when, in fact, DB securities also traded on several other U.S. exchanges.

By far, the most egregious methodological flaw concerned Marek’s failure to account for the impact of the German market on the price of DB’s securities. DB’s experts testified that the German market was the primary price driver of DB securities traded in the United States. Roughly 90 percent of DB’s securities traded in the German market. Although Marek conceded that “German pricing drove U.S. pricing,” the court noted that “Marek did not recognize this fact in his analysis, let alone perform any work to determine whether the German pricing was occurring in an efficient or inefficient market.” Marek’s failure to examine the “primary market in which the security at issue traded undermines any opinion as to whether that security traded in an efficient market.” In addition, the failure to consider the impact of the financial crisis and Marek’s inadequate foundation of testing 12 trading days out of 515 suggested seriously flawed methodology. Specifically, the 12 days tested by Marek corresponded to DB’s earnings disclosure dates. However, due to the enormity of information regarding DB being released into the market around this time, DB’s experts also undermined Marek’s decision to use the earnings disclosure dates as an exclusive test sample.

IBEW had moved to certify purchasers of DB’s ordinary shares on the NYSE from the period of January 3, 2007 through January 16, 2009. DB opposed certification, arguing IBEW was neither typical nor adequate as a plaintiff representing the putative class. DB further asserted that IBEW, as an “in-and-out-trader” (i.e., one who both purchases and sells the security at issue during the class period), was subject to unique defenses. The court held that IBEW satisfied the typicality requirement, but the presence of the unique defenses caused plaintiffs to be inadequate class representatives.

The court’s primary focus in assessing certification, however, concerned the predominance requirement of Federal Rule 23(b)(3). The lack of an “efficient market” meant that each investor in DB securities would have to demonstrate his or her reliance on the alleged misrepresentations in deciding to purchase the security. Because DB successfully rebutted plaintiff’s evidence of market efficiency, IBEW could not rely on the fraud-on-the-market presumption to satisfy the reliance element on a class wide basis. Relying on In re: Flag Telecom Holdings, Ltd., Secs. Litig., 574 F.3d 29 (2d Cir. 2009) (affirming denial of class certification based on in-and-out-trader status), the court explained that IBEW’s “in-and-out-trading patterns … raise individualized questions regarding why they made their investments (was it in fact reliance on the market?) and whether they have loss causation.” As such, “individualized questions as to the named plaintiffs threaten to predominate over common questions.”

Conclusion and Implications for D&O Insurers

It is relatively uncommon for courts in securities fraud cases to refuse to certify a class. It is also somewhat uncommon, given the liberal standard for admission of expert testimony, for courts to refuse to find a purported expert in market efficiency and damages unqualified. Nevertheless, DB’s challenge on the market efficiency issue and the court’s searching analysis may create a template for other cases such that class certification should not be considered a foregone conclusion in securities cases.

Moreover, the case also presents a significant line of defense for foreign issuers. In the post-Morrison era, only their U.S. traded securities may be the basis of securities litigation in U.S. courts. Nevertheless, the heavier volume of their securities traded abroad may impact, or even drive, the market efficiency of the U.S. traded securities. Failing to analyze that factor can, as in IBEW, be fatal to a plaintiff’s case and thereby insulate the foreign issuer from liability in U.S. courts.

Defendants and their insurers should be mindful of the lessons of the IBEW decision when evaluating other securities cases, especially those against foreign issuers.

1 Proving reliance on misrepresentations or omissions is fundamental to making out a securities claim under Section 10(b) and Rule 10b-5 of the Securities and Exchange Act of 1934. Recognizing the difficulties securities plaintiffs encounter in proving reliance directly, the U.S. Supreme Court endorsed the fraud-on-the-market presumption in Basic Inc. v. Levinson, 485 U.S. 224 (1981). The theory rests on the premise that “certain well developed markets are efficient processors of public information” and the price of a security at any given time reflects all publicly available information (including any misrepresentations or omissions). Id. at 5-6, n.3 (quoting Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, __ U.S. __ , 133 S. Ct. 1184, 1191-92, 185 L. Ed. 2d 308 (2013)). The fraud-on-the-market presumption thus allows a plaintiff “to invoke a rebuttable presumption of reliance on material misrepresentations aired to the general public.” Id. (quoting Amgen). The “presumption of reliance is, however, just that – a presumption. It is rebuttable.” Id. at 65 (citing Amgen, 133 S.Ct. at 1193 (citing Erica P. John Fund. Inc. v. Halliburton Co., __ U.S. __ , 131 S.Ct. 2179, 2185 (2011))).

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